The argument set forth to prove that T is not influenced by M or M' is

as follows: "An inflation of the currency cannot increase the products

of farms or factories, nor the speed of freight trains or ships. The

stream of business depends on natural resources and technical

conditions, not on the quantity of money. The whole machinery of

production, transportation and sale is a matter of _physical capacities

and technique_, none of which depend on the quantity of money. The only

way in which quantities of trade appear to be affected by the quantity

of money is by influencing trades accessory to the creation of money and

to the money metal.... From a practical or statistical point of view

they amount to nothing, for they could not add to nor subtract one-tenth

of 1% from the general aggregate of trade." (_Loc. cit._ p. 155. Italics

mine.) Something similar is said on p. 62, where "transitional"

influences of M on T are being discussed: "But the amount of trade is

dependent, _almost entirely_, on other things than the quantity of

currency, so that an increase of currency cannot, _even temporarily_,

very greatly increase trade. In ordinarily good times practically the

whole community is engaged in labor, producing, transporting, and

exchanging goods. The increase of currency of a "boom" period cannot, of

itself, increase the population, extend invention, or increase the

efficiency of labor.[229] These factors pretty definitely limit the

amount of trade that can reasonably be carried on. So, although the

gains of the enterpriser-borrower may exert a psychological stimulus on

trade, though a few unemployed may be employed, and some others in a few

lines induced to work overtime, and although there may be some

additional buying and selling which is speculative, _yet almost the

entire effect_ of an increase in deposits must be seen in a change in

prices. Normally the _entire_ effect would so express itself, but

transitionally there will be also _some_ increase in the Q's." (Pp.

62-63. Italics mine.)

Fisher is here exceedingly uncompromising, even where transitional

periods are concerned, and it is not necessary, in order to do his

position full justice, to make much distinction between "normal" and

"transitional" effects in my counter-argument. I shall, however, take

account of the distinction as I proceed, in justice to other, more

moderate, quantity theorists.

It is a familiar doctrine that the quantity of money is irrelevant, that

things go on in much the same way whether money is abundant or scarce,

the only difference being that in the one case prices are high and in

the other, low; that, in particular, it is a gross fallacy to connect

the rate of interest with the amount of money, since (as many writers

would put it) the rate of interest depends on the amount of _capital_

rather than _money_. At the opposite extreme, we have writers like

Brooks Adams (_Law of Civilization and Decay_), who see the fate of

nations and the progress of civilization resting on the abundance or

scarcity of money. Fisher takes the first position in its extremest

form.[230]

The truth, I think, is intermediate. The effects of the New World

discoveries of gold and silver after the voyage of Columbus on trade and

industry were tremendous. Trade was enormously increased. Walker, in his

_Inter__national Bimetallism_,[231] asking, from the standpoint of a

quantity theorist, why prices only increased 200% while money increased

470%, admits that the chief reason was the increase in trade, due in

large part to the very increase in money itself. Sombart, in his _Der

Moderne Kapitalismus_,[232] finds in this influx of money a tremendous

source of capitalistic accumulations, (a) for the Conquistadores, (b)

for the handicraftsmen whose prices rose faster than their costs, (c)

for tenants whose rents were fixed in money, (d) for landowners, whose

rents were fixed in kind [a point not obviously true], and (e) for

bankers, as the Fugger. An increase of capital, savings that would

otherwise not have been made, must have profoundly modified the whole

industrial system, and greatly increased both industry and commerce. If

it be objected that effects of this sort are not usual, that they came

in a world which had been starved for money, and which, by means of the

enormous increase in money was able to pass from a "natural" to a money

economy, I reply that the difference between such a case and the usual

effects of an increase of money are in degree rather than in kind. The

world of Columbus' day was in part on a money economy, and the world

to-day, despite Professor Fisher's emphatic denial,[233] still employs a

great deal of barter, or equivalents of barter. I shall revert to this

point later. But even this consideration would not rob Sombart's points

of their significance for modern conditions. Further, we have an even

more striking case, on Walker's own showing, in the effects of the

Californian and Australian[234] gold discoveries in the 19th Century on

trade, industry, and speculation.[235]

Nor is the tremendous agitation over bimetallism, involving a literature

so great that no man could dream of reading it all, involving great

political movements, Presidential campaigns, great Congressional

debates, repeated legislation, international conferences, etc., for

twenty years, to be explained on any other ground than that the world

felt practical, important, and unpleasant effects on industry and trade

from the inadequacy of the money supply.

The view of Hartley Withers[236] is interesting here. He says: "any such

great addition to currency and credit would have a great effect in

stimulating production, and so would lead to a great addition to the

number of real goods which humanity desires and consumes when it can get

them.... Trade would be more active." On p. 23 he speaks of the enormous

expansion of trade made possible by paper representatives of gold. On p.

83 he speaks of the attitude of the money-market toward gold, which the

orthodox economist is apt to think of as a survival of Mercantilism.

Withers thinks that the money market is right in a large degree.

As illustrating Withers' statement about the views of "practical men" on

this point, the following extract from a recent address by Theodore

Price, quoted with approval in a "market letter," written by Byron W.

Holt,[237] is interesting: "The fact seems to be that the exigencies of

war in Europe are leading to an extension of credit such as would not

have been possible in peace, because the hesitant conservatism of

bankers would have then prevented it, and we are finding that instead of

working harm it is doing good, because huge masses of fixed capital are

thereby made productive, and are circulating with the increased velocity

that always quickens enterprise and accelerates the wheels of

industry.... All the precedents of history indicate that accelerated

activity will come with peace and continue until the exuberance of

success has led men to build faster than the world has grown and to

demand credit upon the basis of future rather than of present values."

What is the essential causation in the matter? Well, viewed merely as a

matter of mechanical equilibration, the quantity theory view is not

strictly true, by any means. For a given country--and Fisher's quantity

theory is always a theory for a given country, and, indeed, for any

separate market, even a single city[238]--an increase of banking credit

means an increase in non-monetary capital, because, to a greater or less

extent it dispenses with the use of gold, which goes abroad, bringing

back wealth in other forms in exchange. Adam Smith saw this clearly,

and phrased it strikingly, likening gold and silver coins to the

wagon-roads of Scotland, which are necessary for transportation, but

which none the less prevent the use of the roadways for raising grain;

whereas bank credit is like a wagon-road through the air, which restores

the roadbeds to cultivation. Increased non-monetary capital, other

things equal, should mean increased trade.

But, more fundamentally, an increase in gold itself within the country,

if not bought by the export of an equivalent amount of other goods, _is

an increase of capital_. Not all capital is money, but standard coin is

capital. Money is a tool of exchange, and exchange is part of the

productive process. More money means more exchanging. That is what money

is for. Part of the mechanism is in the money rates, which go down as

money becomes more abundant, making it profitable to effect exchanges

which would not have been profitable had the money rates been higher.

Granted that the money-rates and the general rate of interest tend, in

the long run, to keep--I will not say at the same figure[239]--a certain

fairly definite relation to one another, it still does not follow that

the new "normal" equilibrium will give us an interest rate which is the

same as the general rate of interest was before the influx of gold. On

the strictest static theory, this is not to be expected. Because the

total amount of capital in the country is increased, and this means a

lowered interest rate all around, in the marginal employment of capital.

The margin of the use of capital will be lowered everywhere, including

the margin for the use of money. This means permanently lowered money

rates in the country, even though the permanent level be higher than the

initial money rates immediately following the access of new gold. I

have put the argument in terms that suggest the productivity theory of

interest, because it is more simply stated that way. I do not accept the

productivity theory, as a fundamental explanation of interest, but for

many purposes, the results to be obtained by it coincide with the

psychological time theories,--which also, in their present form, seem to

me imperfectly developed. I need not try to construct a theory of

interest here, however, as the familiar theories lead to no trouble at

this point. It is enough to point out that the increased amount of

capital, meaning better provision for present wants--wants concerned

with gold in the arts and with money for productive exchanges, as well

as goods generally since part of the new gold will be exported for other

things--will lessen the pressure of present as compared with future

wants, and so lessen the rate of interest on the time-preference theory.

The final outcome will be an extension of the marginal use of money, and

a greater volume of exchanges. Of course, the increase in the supply of

any kind of capital good, apart from a prior increase in the demand for

its services, will, on the mechanical view of economic causation,

necessarily lead to some fall in its capital value. Gold money will be

no exception to this rule. As to how much the increase in its quantity

will lead its capital value to fall, however, we are unable to say. For

the quantity theory, the fall will be in proportion to the increase. For

the theory just outlined, the fall will depend on the elasticity of

demand for gold in the arts, and on the elasticity of "demand" for

money, meaning by demand for money simply the demand for the short-time

use of money as a tool of exchange, a demand which governs _directly_,

not the capital value of money, but rather the "money-rates." The

relation between the money rates and the capital value of money will

best be discussed at another point.[240] We have no reason at all to

suppose that either of these demands[241] exhibits the tendency to obey

the law of proportional variation which the quantity theory requires of

money.

It is further important to note that as a country gets more abundant

capital, there seems to be a tendency to extend the use of money rather

more than the use of many other capital goods. Where the interest rate

is 10 and 12%, as in Arizona and New Mexico, money, even when brought

in, tends to leave in large degree to bring in other forms of capital

which the situation calls for more imperatively. The early American

colonies, needing money pressingly, and making shift with a great

variety of substitutes for good metallic money, thoroughly acquainted

with the advantages of a money-economy from their European experience,

and having "habits" as to the carrying and using of money which they had

brought with them from Europe, still found it impossible to keep a great

deal of metallic money, in view of the still greater importance of other

forms of capital. It is in the most highly developed commercial

communities, commercial centres, and _par excellence_, in the

speculative centres, that the demand for the money-service is most

elastic.[242] A country where the rate of interest is low, loses other

forms of capital, and gains money, in the process of reequilibration, as

compared with a new and undeveloped section, although the new section

also extends the margin of the money service, in effecting a greater

number of exchanges, when money is increased.

And this leads to a vital distinction, which quantity theorists almost

always lose: the distinction between the volume of _production_, and

the volume of _trade_. Even in the mechanical system of causation which

they describe, it is true only of production and transportation that

_technical_ and _physical_[243] factors are of primary significance, and

that money is of minor significance. For trade and commerce, money is

always highly important. To the extent that a region is primarily given

over to the primary productive activities, mining, and agriculture, such

trading as is necessary can be done by means of a small amount of money,

supplemented by barter and long-time book-credit. A region or a city

whose chief business is _commerce_, however, needs a large part of its

capital in the form of money, and of banking capital, which is largely

invested in money for banking reserves. _Trade_, as distinguished from

industry (and it is after all trade that is under discussion), is helped

or hindered as its tools are more or less abundant. These considerations

would suggest that the elasticity of the demand for the use of money is

greater than the elasticity of demand for the use of capital in almost

any other form. Production is, indeed, limited by labor supply and

natural resources, in considerable degree. _Trade_,[244] however, even

from the standpoint of mechanical causation, is limited chiefly by the

relation between the profits to be made in commercial transactions, and

the "price" that must be paid for the money and credit that are required

to put them through. There are enormous numbers of transfers that could

be made to advantage if there were no cost at all involved. They are not

made, because exchanging requires pecuniary capital. Let the pecuniary

capital increase, however, and sub-marginal exchanges become worth

while, the general margin is lowered. Commerce is the most highly

flexible and elastic portion of the whole productive process. The

elasticity of demand for commercial capital is, thus, greater than the

elasticity of demand for any other form of capital.

How widely the volume of trade differs from the volume of production,

and how great is the element of speculative transactions in trade, will

best appear, I think, from an analysis of the figures which Fisher

gives[245] for the volume of trade in the United States. His figure for

the volume of trade in the year 1909 is $387,000,000,000.00, three

hundred and eighty-seven billions of dollars! This figure is reached by

equating the figures he has reached for MV plus M'V' to PT, and assuming

P to be one dollar, by making the "unit" of T, arbitrarily, a dollar's

worth of each sort of commodity, at the prices of 1909. I have already

commented on the legitimacy of this method of summarizing T,[246] and

need not say more here, beyond calling attention to the fact that

"volume of trade," as commonly used, does in fact mean, not T alone, but

PT. Fisher for years other than 1909, however, makes use of a different

method of getting at T: he takes certain indicia of _relative_ amounts

of trade, compares them with the same indicia for 1909, and estimates

the trade for other years as being such a percentage of the trade for

1909 as their indicia are of the indicia of 1909. The indicia chosen

are: (1) quantities of certain commodities, cotton, fruit, cattle, etc.,

_received at_ principal cities of the United States, taken as typical of

the variations of the internal _commerce_ of the United States; (2)

quantities of 23 articles of import and 25 articles of export, for each

year, taken as typical of variations in the foreign trade of the United

States; (3) sales of stocks. These three indicia, weighted in a manner

to be described in a moment, are then averaged. There is a second

element in the index, made up by taking the figures for railroad

_tonnage_, and the figures for _receipts on first class mail_, which are

averaged. The first average and the second average are then combined

into a third average, which is the final index. The relation between

this index for every year other than 1909 and the same index for the

year 1909 determines the amount of T for each year--the two indicia,

together with the figure, $387,000,000,000.00, giving the required

amount by the "rule of three." I shall not go into details with the

method of constructing these averages, but I wish to make clear the

comparative _weight_ given to each element in the final index: The first

three elements count _twice_ as heavily as the last two, and so

constitute the biggest factor. In the first average, based on the first

three elements, the item taken as typical of internal trade is _weighted

by 20_, the item taken as typical of foreign trade is _weighted by 3_,

and sale of stocks _by 1_. It appears from Fisher's figures (p. 479),

that the one really big _variable_ among all the indicia is the sale of

stocks, but the weight given it is so small that it makes virtually no

difference in the final result. Thus, as between 1898 and 1899, stock

sales increased over 50%, but total trade, as shown by Fisher, increased

only 5%. In the following year, stock sales _decreased_ over 21%, but

total trade, on Fisher's figures, _increased_. The following year, 1901,

stock sales virtually doubled, but Fisher's final figure shows only an

increase around 13%. Two years later, in 1903, stock sales fell off

about 40%, from the figures for 1901, but again, as compared with 1901,

total trade on Fisher's figures shows an appreciable gain. The influence

of stock sales on Fisher's index is, virtually, negligible. The

dominating factor is the _receipts_ of selected staples, cattle,

cotton, rice, pig iron, etc., in the principal cities of the United

States. There is not a _single year_ in which his final figure for T

does not move in harmony with this factor (p. 479). He gets, thus, for

the volume of trade through the fourteen years under consideration, a

surprising steadiness, and a pretty uniform progressive development.

In defence[247] of his method of weighting, Fisher says, simply: "These

weights are, of course, merely matters of opinion, but, as is well

known, _wide differences in systems of weighting make only slight

differences in the final averages_." (Italics mine.)[248]

Are these figures valid? Well, first one is struck with the absolute

magnitude assigned to T. The figures seem vastly greater than would have

been anticipated. The method of calculating it, for 1909, I shall

discuss in detail in the chapter on "Statistical Demonstrations of the

Quantity Theory." For the present, it is enough to note that the

absolute magnitude is derived from figures collected by Dean David

Kinley for the National Monetary Commission,[249] of deposits, exclusive

of deposits made by one bank in another, made in about 12,000 banks (out

of 25,000) on March 16, 1909. These deposits were classified as (1)

money (with subdivisions) and (2) checks and other credit instruments. A

cross-classification divided them into (1) retail deposits; (2)

wholesale deposits; (3) all other deposits. Kinley's object was to

determine the extent to which checks are used, as compared with money,

in payments, particularly in wholesale and retail business. Fisher's

total, briefly, was obtained as follows: Kinley's figures, for the one

day, were increased to make an allowance for the non-reporting banks;

they were further increased on the assumption that March 16 was below

the average for the year; the figure finally obtained for the day was

then multiplied by 303, assumed as the number of banking days in the

year, and the product, 399 billions, was taken as representing the total

circulation of money and checks in trade. For some reason not made

clear, this total was subsequently reduced to 387 billions. Counting the

average price, P, as $1, T was considered to be 387 billions.[250]

In the statistical chapter to follow, it will be shown that this

estimate is a very decided exaggeration. Deposits made in banks greatly

overcount trade. Very many payments represent duplications, loans and

repayments, taxes, etc., and are in no sense trade. This is true of all

classes of deposits, wholesale and retail, as well as "all other." But

for the present, I am concerned with the question, not of the absolute

magnitude of the volume of trade, but rather, the questions of its

character, of the elements that enter into it, and, above all, of the

extent to which it is physically determined by technical conditions of

production, and the extent to which it is flexible, a matter of

speculation, etc.

We may approach this question from the angle of several bodies of

statistical information. First, the question may be raised: what is

there in the country which could be bought and sold enough in the course

of a year to give us anything like so great a total? The subtractions

which we shall find it necessary to make will still leave us an enormous

total.

The United States Census Bureau[251] in 1904 reached the conclusion that

the _total wealth_ of the country was only $107,000,000,000. Of this,

over $62,000,000,000 was in real estate; $11,000,000,000 in railroads;

street railways, over $2,000,000,000; telephone, telegraph, water and

light, and similar enterprises total nearly $3,000,000,000 more. None of

these things enter into ordinary wholesale and retail trade. The items

that one would ordinarily think of are agricultural products,

$1,900,000,000; manufactured products, $7,400,000,000; mining products,

$400,000,000. Can these things be exchanged often enough in the course

of a year to account for $387,000,000,000!

These figures are for 1904,[252] whereas Fisher's figures are for 1909.

If the Census Bureau had taken an inventory in 1909, the figures would

doubtless be larger. The inventory for 1912 made by the Census Bureau

does show a very considerable increase, the largest item being due to a

rise in real estate values. The figures for agricultural, manufacturing,

and mining products are, also, figures for a given time rather than for

total production through the year. But, making all the allowance one

pleases, it is quite incredible that one should reach a figure of

$387,000,000,000 by taking only the exchanges necessary to bring raw

materials through the various stages of production to the consumer. The

greater part of the $387,000,000,000 is to be explained in another way!

A detailed analysis of Kinley's figures, on which the estimate of total

trade is based, leads clearly to the same conclusion. Kinley's figures

for the banks that reported on March 16, 1909, are as follows:

Retail deposits 60 millions

Wholesale deposits 124 millions

"All other" deposits 502 millions

The "all other deposits" are vastly greater than retail and wholesale

deposits combined! Notice, too, with reference to the question as to how

often goods need to be turned over in getting to the consumer: wholesale

trade uses only about twice as much money and checks as does retail

trade. Goods are not, if these figures are in any way typical of actual

trade, turned over many times in the process of reaching the consumer.

The "necessary," or "physically determined" number of exchanges, in the

routine of trade, is small, per item.

Retail deposits of 60 millions make up less than one-eleventh of the

total. Retail and wholesale deposits together make up about

three-elevenths. What is the other eight-elevenths, represented by the

"all other deposits"? It will help if we see where these "all other"

deposits are located. If we find them scattered evenly throughout the

country, in rural regions as well as in cities, we might be at a loss.

If, however, we find them bunched in the big speculative centres, we may

conclude that speculation accounts for a large part of them. We do in

fact find this.

The following figures show the different classes of deposits (1) in the

South Atlantic States; (2) in reserve cities; (3) in New York City

alone:

_South Atlantic States:_ _Per Cent._

Retail deposits $ 3,300,000 19.0

Wholesale deposits 4,900,000 29.0

"All other" deposits 8,900,000 52.0

_Reserve Cities (including New York City):_

Retail deposits $ 24,000,000 5.6

Wholesale deposits 78,000,000 18.2

"All other" deposits 326,000,000 76.1

_New York City:_

Retail deposits 9,000,000 3.7

Wholesale deposits 34,000,000 14.0

"All other" deposits 198,000,000 82.2

It is difficult, with Kinley's figures, to get figures which exclude

returns from cities of substantial size, except for a State like Nevada,

where the mining and divorce industries complicate the figures. As near

an approach as can be made, perhaps, is to take the State of Louisiana,

excluding New Orleans from the totals. Even here, however, we include

five cities of over ten thousand, among them Shrevesport, with 28,000

people. The following figures are for the State and national banks in

Louisiana, exclusive of New Orleans:

Retail deposits $179,915 24.1

Wholesale deposits 246,647 33.1

"All other" deposits 318,915 42.8

We cannot tell, in these figures for Louisiana, how many banks are

represented, or what the average figures per bank are. For the whole

State of Arkansas, however, including five cities of over 10,000, with

two over 20,000, and one of 45,000, we can get an average for ninety

reporting banks. Even here we do not know where these banks are located

within the State; though it is probable that they are in the larger

places, and so exceed the average deposits for the banks in the State as

a whole, to say nothing of the average for the smaller places. The

ninety banks are almost wholly State and national banks.

_Arkansas:_ _Per Cent._

Retail deposits $232,017 25+

Wholesale deposits 231,614 25+

"All other" deposits 456,544 49+

The average for all deposits, per bank, in Arkansas is $10,224; the

average for all the 11,492 banks reporting for the whole country is,

approximately, $60,000; the average for the 659 banks reporting from New

York State is $502,136; the average for the banks in New York City alone

is doubtless much higher, but cannot be stated, as Kinley's figures do

not tell how many banks reported by cities.[253]

The "all other deposits" in Arkansas are 27.8% cash, and 72.2% checks;

the "all other" deposits in the country as a whole are only 4.1% cash,

with 95.9% checks; the "all other deposits" of New York City are only 1%

cash, with 98.9% checks.

Several facts are very clear from these comparisons: (1) the proportion

of "all other deposits" increases very rapidly as we get closer to the

great centres of speculation, and is lowest in rural regions; (2) the

great bulk of all the deposits is in the cities. The average for

Arkansas banks, for example, is only one-sixth the average of the whole

country, and is only one-fiftieth the average for the banks of New York

State. It is a much smaller fraction of the average for New York City,

but we cannot give an exact figure. The totals reported from the rural

regions are trifling, as compared with the totals reported from the big

cities. This, as will be made clear in the chapter on "Statistical

Demonstrations of the Quantity Theory," is not because the country

reports were less complete that the city reports. New York was probably

less complete than the country as a whole. It is simply because the

activity of country accounts is small, the amount of trading in the

country districts small, and (as shown) the _average_ for country banks

is small. (3) The character of the "all other" deposits in Arkansas

differs substantially from that of the "all other" deposits in New York

City, as indicated by the fact that the proportion of cash is high in

Arkansas--substantially higher, in fact, for the "all other" deposits in

Arkansas than for all deposits, or even for retail deposits, in the

country as a whole. The percentage of checks in total retail deposits in

the United States, in Kinley's figures, was 73.2; the percentage of

checks in the "all other" deposits in Arkansas was 72.2. We may count

these Arkansas "all other" deposits as, in considerable degree, deposits

made by farmers. What were the "all other deposits" made in New York

City?

Dean Kinley's list of the miscellaneous elements that enter into the

"all other deposits," given on p. 151, contains only two that might be

expected to bulk large in New York without appearing in Arkansas. These

are: _brokers_, _and stock and bond financial corporations_. Of course,

theatres, hotels, publishing houses, railroads, public funds, "those

who have no specific business," and rich churches, will all be

absolutely much larger in New York City than in Arkansas. But these

things may be found in many places, scattered throughout the cities of

the country, without making anything like such "all other" deposits as

New York shows. It is not New York's foreign commerce that does it,

because that is represented in New York's "wholesale deposits," which

make up only 14% of New York City's total deposits for the day. It

cannot be the supposed "clearing house" function of New York City,[254]

whereby banks in different parts of the country pay their balances due

one another in New York exchange, because such transactions would appear

in New York chiefly in the figures for deposits made by one bank in

another, and these figures are excluded from Kinley's totals. It cannot

be the deposits of the "idle rich" for current expenses that swell New

York's "all other deposits" so greatly--these could not equal the total

retail deposits of the city, which are only 3.7% of the total in New

York. Moreover, similar deposits are made in many other cities, without,

in proportion to population, making any such totals. Figures, moreover,

for the aggregate yearly income of the United States, and for the

distribution of that income between rich and poor, make it clear that

any such items must be bagatelles in comparison with these enormous

figures. The only explanation that will really explain is the

speculative and investment and financial transactions that centre in New

York, and, in less degree, in the other great financial cities of the

country.

This is Dean Kinley's opinion. In the "all other" deposits he makes a

50% allowance for speculative transactions. "A large proportion of

deposits in this 'all others' class undoubtedly represents speculative

transactions, all of which, or practically all of which, are settled

with credit paper."[255] It is also the opinion of General Francis A.

Walker, expressed concerning similar figures from earlier

inquiries.[256]

Various kinds of evidence converge toward this conclusion. Thus, the

evidence of clearings, total items presented by banks to the clearing

houses of the country. New York clearings are usually nearly twice as

great as total clearings for the rest of the country. New York clearings

fluctuate in general harmony with transactions on the New York Stock

Exchange. This has been commented on many times. The extent to which it

holds has recently been carefully measured by Mr. N. J. Silberling,

whose results appear in the _Annalist_ for August 14, 1916, under the

title, "The Mystery of Clearings." Mr. Silberling applies the

"coefficient of correlation" to the problem, getting in one significant

figure a measure of the extent to which two variables, as share sales on

the New York Stock Exchange and New York clearings, vary together. This

coefficient has been used enough by economists not to require detailed

explanation here. It is a figure always between +1 and -1. +1 indicates

that the two variables in question are perfectly correlated, whereas 0

indicates no correlation whatever. -1 indicates an inverse correlation,

such that two variables vary exactly and inversely with reference to one

another.[257]

Mr. Silberling's studies show the following correlations: New York share

sales (numbers of shares, not values) to New York clearings, using

weekly figures, for the years 1909-10, r = .628. This is a high

correlation. Limiting the observations to the middle weeks of the month

for the same period, he gets r = .731(46). The reason for taking only

middle weeks in the month is that thereby the disturbing factor of

monthly settlements is avoided. The monthly settlements may be for stock

transactions, or may be for other things, but as they are not dependent

on the stock transactions _of the week_ in which they occur, their

effect is to lessen the evident degree of connection between stock

sales and clearings. Thus the middle weeks show a closer correlation

between the two variables than do all the weeks taken as they come. If

figures for the month were taken, this complication would be smoothed

out, and a fairer result might be expected to appear. The middle weeks,

eliminating monthly settlements, probably eliminate more other things

than they do share sales (which are in large degree paid for in 24

hours[258]), and so exaggerate somewhat the relation between shares and

clearings. Monthly figures avoid both complications, though they lose

something of the concrete causation. An intermediate figure might be

expected for the monthly correlation, and this we find: r = .718(23).

A striking single fact in connection with these figures, giving them

point as less extreme variations could not do, is found in the behavior

of clearings when the Stock Exchange was closed, during the crisis of

1914. At that time, New York clearings, which had been about twice as

great as country clearings, fell suddenly _below_ country clearings.

When the Stock Exchange was opened, the old proportions suddenly

reappeared.

That speculation spreads far beyond New York, New York being the centre

for dealings in securities, etc., which involve the whole country, is,

of course, well known. The extent of this Mr. Silberling seeks to

measure by correlating clearings outside New York with New York share

sales. His weekly correlation for these two variables for 1909-10 gives

r = .368(103), and the correlation for the mid-weeks gives a higher

figure, r = .424(46). The monthly correlation shows r = .257(23), a

lower figure, "which is perhaps due in part to the fact that the bulk of

the outside monthly clearings show relatively moderate fluctuations,

because of their diverse composition, and are less sensitive than the

periods of shorter length."

Seeking an index of the variations of that trade which is, in Professor

Fisher's phrase, governed by "physical capacities and technique"--a law

which Professor Fisher,[259] as we have seen, would apply to the great

total of 387 billions which he has constructed--Mr. Silberling chooses

the gross earnings of the principal railways as the best available test.

Railways deal with all manner of other enterprises. He correlates this

with clearings outside New York. "The question might arise at once

whether changes in traffic are strictly concomitant with changes in

payments involved by it, and therefore with the clearings resulting. The

preliminary hypothesis that a 'lag' ensued between traffic and the bulk

of the payments was first tested by correlating the railway figures with

clearings of one month[260] and two months later, but no correlation was

obtained. The direct month-to-month correlation yielded, however, a

result r = .524(23)." This suggests that outside clearings are, in

substantial degree, an index of physical trade, but Mr. Silberling calls

attention to certain chance agreements between railway traffic and

speculation in cotton and produce and grain, speculation in the crops

which are in current movement, and regularly recurring concomitances

between traffic and speculation in March, when the railway traffic

revives after the February lull, and when there is a large mass of

dealing in Spring deliveries in Chicago. In view of the facts later to

be developed, with reference to the small actual value of the necessary

physical exchanges (partially covered already) as compared with

clearings, this query is well put. We may easily have here a "spurious"

correlation. Taking it at its face value, however, and taking the

correlation as indicating the influence of physical trade on bank

transactions, we get the following results, when _total clearings for

the country_ are compared with (a) New York share sales, and (b) with

railway gross earnings: (a) r = .607(23); (b) r = .356(23). "Physically

determined trade" is at best a minor factor in that total "trade"

represented by bank transactions!

Mr. Silberling has buttressed his results with a consideration of

various alternative possibilities which might give them a different

interpretation. I need not, for present purposes, go further into his

figures.[261] Taken in conjunction with the other data presented, and to

be presented, together with the theoretical discussion of the nature of

trade, and its relations to money and credit, which the present volume

contains, they give the present writer abundant confidence in the thesis

that the great bulk of trade in the United States is SPECULATION, rather

than that sort of trade which is determined "by physical capacities and

technique."

The figures given above, of the inventory of wealth at a given moment of

time, by the Bureau of the Census, show only trifling magnitudes, as

compared with the estimated 387 billions of deposits made in 1909, of

items which could enter into ordinary trade, as distinguished from

speculation and dynamic readjustments. An effort to calculate ordinary

trade on the basis of figures running through the year may throw further

light on the problem. Railway, gross receipts for the year ending June

30, 1909, were less than two and a half billions. This is six-tenths of

1% of the total. Receipts of the Western Union Telegraph Company were

$30,451,073--less than one-hundredth of 1%. The Post Office in the

fiscal year ending in 1909 took in $203,562,383. This is something over

one twentieth of 1%. These are gigantic sums. But they are insignificant

indeed in this computation. Millions of smaller items simply do not

count at all--ten million items of $387 each would give only 1%. The

total net income of the United States, as estimated by W. I. King for

1910, including all forms of income, dividends, interest, wages, rents,

profits, salaries, etc., is $30,500,000,000[262]--around 7% of the 387

billions.

Let us sum up the major items of ordinary trade. From Kinley's figures,

we may get some idea of the proportions of wholesale and retail trade to

the total for 1909, assuming that the deposit figures indicate that

total. Retail deposits make up less than one-eleventh of the total, and

wholesale deposits about two-elevenths. The figures were: retail, 60

millions, wholesale, 124 millions, and "all other," 502 millions. But

the "all other" deposits were lower than normal. New York City was, in

the first place, probably less complete than the rest of the country, in

the figures returned, and, in the second place, New York City, as shown

by the clearings of March 17 (the next day, when checks deposited in New

York would get into the clearings) was 28% below normal. The rest of the

country was within 3% of normal.[263] Not to refine matters too much, we

shall, on the assumption that the variable element in New York deposits

is connected with the Stock Exchange (as shown by Mr. Silberling's

correlations and other considerations), and on the assumption that

deposits connected with the stock market appear in the "all other"

deposits, add a little over 20% of New York's total of 198 millions, or

40 millions, to the "all other" deposits for the country, leaving the

wholesale and retail deposits unchanged. What error there is in this is

favorable to the wholesale and retail deposits. Our proportions, then,

are: retail, 60, wholesale, 124, "all other," 542, total, 726. If the

retail deposits correctly represented retail trade, we could then say

that retail trade was a little less than one-twelfth of the whole, and

wholesale trade about one-sixth. But there are many speculative

transactions engaged in by wholesalers, and a good many by retailers.

The writer knows a small delicatessen dealer on Amsterdam Avenue, in New

York, who frequently speculates in eggs and canned goods. A colleague in

the Harvard Graduate School of Business Administration is authority for

the statement that speculation in canned goods and some other things is

quite common among retailers, particularly "hedging" by the use of

"futures," in canned goods. Speculation among wholesalers is very

extensive. The same is true of manufacturers. The same authority cited

some cotton manufacturers whose profits from cotton speculation are

greater than their profits from manufacturing. We shall see reason to

suppose that a very substantial part of manufacturers' deposits were

included in the wholesale deposits. That the figures for retailers'

deposits exaggerate the retail trade may appear from several

considerations: (1) The proportion of checks to cash reported is too

high: 73.2%. Dean Kinley allows 5% of the checks deposited to be

"accommodation checks,"[264] cashed for customers, rather than taken in

in trade. (2) If retail deposits are taken as exactly representative of

retail trade, we should get a retail trade for the year of over 32

billions (1/12 of 387 billions), which would exceed the total income of

the country as calculated by King for 1910. Dean Kinley reached the

conclusion that the retail deposits reported in 1896 also exceeded the

probable retail expenditures.[265] Of course, not all of retail trade is

in consumption goods. Hardware stores, lumber stores, and some other

retail establishments sell, not only to householders for domestic use,

but also things which enter into further production, and so do not come

out of annual income. If we include in retail trade various items which

were not included there in Kinley's figures, such as hotels, theatres,

newspaper receipts from subscription and street sales, physicians' fees,

etc.--all those items which enter into the domestic budget, including

domestic service, we should still not be justified in reaching a total

as great as the total income of society, since there would then be no

allowance for savings, which we should not count in trade, or for life

insurance, which we shall count separately. The items sold at retail

which enter into further production cannot make a great total, since

large producers buy such things at wholesale. Total retail trade,

therefore, and, in addition all the other items in the domestic budget,

must be held below the figure for total national income. Suppose, to be

very liberal, we allow 29 billions[266] for all these items, under the

general head of "retail trade."

For wholesale trade, if we take the figures at face value, the estimate

would be 65-3/4 billions (124/726 of 387 billions, or 17% of 387

billions). But we have seen that there is a great deal of speculation

among wholesalers. Not all of their deposits, by any means, represent

receipts from ordinary business. Moreover, there is much overcounting

here, several checks being used for one transaction, especially where

wholesalers have branch houses, and checks connected with loans and

repayments, and transfers of funds from one bank to another. How much we

should subtract for this there is no way to tell. In the case of retail

figures, we have the additional check of the figures for total net

income, but there is no such check here. We shall, therefore, make no

subtraction, but shall content ourselves with pointing out that we are

allowing many billions[267] to "ordinary trade" to which it is not

entitled, which will much more than offset errors in the opposite

direction which the reader may find in our computations.

Do manufacturers' receipts from first sales belong in the wholesale

deposits, or must they be counted as a separate item? Dean Kinley does

not say. In his list of items, as reported by banks, that go in the "all

other" deposits,[268] he does not mention manufacturers, and the item is

far too important not to have been mentioned by so careful a writer had

he supposed that it belonged there. If manufacturers' first receipts

belong, not in the wholesale deposits, but in the "all other" deposits,

then we should expect manufacturing cities to show a high percentage of

"all other" deposits as compared with wholesale deposits. The city of

Pittsburg should be a good test case. The figures there, for State and

national banks and trust companies, are:

_Per Cent._

Retail deposits $1,061,420 9.6

Wholesale deposits 3,368,004 29.7

"All other" deposits 6,672,378 60.6

For Pittsburg, the percentage of "all other" deposits is lower decidedly

than the percentage for the country as a whole (about 75%), much lower

than for cities where there is active speculation, as Chicago and St.

Louis, to say nothing of New York, and is closer to the percentage of

the South Atlantic States, 52%, than to the average for the country. The

wholesale deposits of Pittsburg, however, rise to 29.7%, as against an

average for the country of 17%. There is nothing in these figures to

suggest that manufacturers' first receipts are exclusively in the "all

other" deposits. I should think it safe to hold that a substantial part

of them were included in wholesale deposits, and so already accounted

for in our estimate. The total value of products manufactured in 1909

was $20,672,051,870. I shall allow $5,672,051,870 of this to have been

already accounted for in our estimate of wholesale trade, and count 15

billions of it as a separate item. If there is an error here, it is very

much more than offset by our failure to subtract anything from the

wholesale figures for speculation. I think it probable that much more of

the figures for manufactures should be assigned to the wholesale figures

than I have assigned.

To these figures, we may add a number of other items, absolutely great,

but insignificant, in comparison with the 387 billions not only, but

also with the figures for retail and wholesale trade already reached.

These are: total farm value of farm products (not nearly all of which is

sold off the farm) $8,760,000,000; total mineral products,

$1,886,772,843; total mill value of lumber, $684,479,859; total life

insurance premiums (much of which is savings, and in no proper sense

trade), $748,027,892; total fire, marine, casualty and miscellaneous

insurance, $362,555,850; total wages and salaries, $14,303,000,000;

total land rent, $2,673,000,000;[269] and the items for railway gross

receipts, post office, telegraph, already mentioned. The total of these

items, together with retail and wholesale trade and manufactures, is

$141,860,618,000. This is only 36.6% of the total of 387 billions. It

leaves over 245 billions unexplained. What can the 245 billions

represent? There is really no way in which ordinary trade can make up

more than a very few more billions, so far as I can see. There remain no

items as big as 1% of the total, and, as we have seen, small items, of

hundreds of dollars each, are like "infinitesimals of the second

order"--they simply do not count at all when such staggering figures are

involved.[270]

There remains, then, a total of 245 billions of check and money payments

which are for something other than the ordinary trade of the country.

What do these payments represent? Much of this total represents

overcounting and duplications of various kinds, which we shall consider

in a later chapter. Much of it also represents speculation and dealings

other than speculative in securities. When we seek to find actual

figures of transactions in any field, retail, wholesale, or speculative

markets, or anything else, it is exceedingly difficult to find anything

that approaches the amounts indicated by the banking transactions

connected. I do not think that a record of all sales would show retail

sales or wholesale sales anything like so great as the figures as we

have allowed for them on the basis of the retail and wholesale deposits.

When we look at the recorded figures of transactions on the speculative

exchanges (or at estimates which competent observers make when records

are not available), the figures, though very large, do not begin to

equal the banking figures with which we have to deal. The New York Stock

Exchange in 1909 showed sales, recorded on the ticker, of nearly 215

million shares of stock, with an approximate value of over 19

billions[271] of dollars. This was not an extraordinary year. In 1901

nearly 266 million shares were sold, in 1905, over 263 millions, in

1906, over 284 millions. A number of other years have approached the

figures for 1909. If stock sales be a good index of general speculation,

1909 is a very satisfactory year from which to have got figures, as

showing neither extreme speculation, nor extreme dullness--which latter

was the case in 1896 when Kinley's other big investigation was made. The

figures for shares sold, however, do not exhaust the business done at

the New York Stock Exchange. "Odd lots," _i. e._, sales of less than 100

shares, are not recorded on the ticker. Mr. Byron W. Holt estimates that

from 25 to 30% would be added if they were counted. DeCoppet and

Doremus, of New York, who handle at least as much of the "odd lot"

business as any other New York house, have given me the following

information about the "odd lot" business: (1) the volume of odd lot

sales is, roughly, from 20 to 25% of the volume of hundred share sales;

(2) the odd lot business fluctuates in conformity to the hundred share

market; (3) the odd lot speculator is just as likely to be a "bear" as

is the hundred share speculator, and, in general, odd lot business is

like the hundred share business. If we take the figure on which these

two estimates agree, 25%, we may add 53-3/4 million shares to our 215,

getting 268-3/4 million shares for 1909, with a value of about 24

billions. Bond sales recorded would add about 1 billion more. There are,

further, some unrecorded sales, indeterminate in amount, but sometimes

very substantial, when brokers have a number of "stop loss" orders. They

match these before the market opens, and, if the prices are reached in

the actual trading, these sales become effective automatically, without

getting on the ticker. How extensive this is cannot be stated. It may

sometimes add very substantially.[272] Thus, on the floor of the New

York Stock Exchange we have dealings in excess of 25 billions for 1909.

This is nearly as large as the figure we have assigned, on the basis of

the bank figures, to total retail trade of the country, and it may well

exceed the retail trade in fact. Recorded sales on other stock exchanges

do not, in the aggregate for the country, bulk very large. For 1910,

when New York shares reached 164 millions, the total for Boston,

Philadelphia, Chicago, and Baltimore was something over 21 million

shares.[273] The New York Curb has had "million share" days, but the

average value of shares is low. But the dealings on the floors on the

exchanges and "curbs" are far from all of the dealings in securities!

Only securities which have been admitted by the authorities are dealt in

on the exchanges. The volume of unlisted securities is enormous.

Moreover, not all, by any means, of the sales of listed securities take

place on the floors of the exchanges. The bond expert of a large banking

house in Boston informs me that the "over-the-counter" business in

Boston, both for stocks and for bonds, much exceeds the business in the

Boston Stock Exchange, and others among Boston brokers have expressed

the same opinion. The statement has been repeatedly made in the

financial press that of the bonds listed on the New York Stock Exchange,

ten are sold over the counter for one sold on the floor. Evidence on

this point is not to be had in definite figures, of course, but I have

found no one in Wall Street who regards it as extravagant. A single big

bank in New York sold $550,000,000 in bonds in 1911--more than half the

recorded bond sales on the Stock Exchange.[274] I should not know how

to estimate the volume of outside dealings within many billions of

"probable error." If ten billions of listed bonds are sold over the

counter in New York alone, we may well suppose that the volume of

over-the-counter sales of listed and unlisted securities at least is not

smaller than the recorded sales on the floors of the exchanges. But this

is all guess work. There are no definite data.

For produce, cotton, and grain speculation we have, in general,

estimates rather than records. For the Board of Trade, in Chicago, there

is one quite striking piece of information. That is that the Federal War

Tax of 1 cent per hundred dollars on grain and provision futures on the

exchanges produced $2,000,000 in Chicago alone in 1915.[275] For the

purposes of the tax, deliveries within thirty days were counted, not as

futures, but as "spot" transactions. The tax was collected almost wholly

on grain. If the above figure is correct, then it is clear that dealings

in these futures of over thirty days aggregated 20 billions of dollars

worth. This gives no estimate of spot transactions, which are, however,

very great. All this trading involved less than 400,000,000 bushels of

grain received at Chicago--a little over a billion bushels were received

at all primary markets. The grain received at Chicago was, thus, (at

80 c. per bushel), sold sixty-two times over in these futures, and an

unknown number of times in spot transactions. There are further enormous

spot transactions in provisions of various kinds at Chicago.

Chicago is the great centre, of course, for this kind of speculation in

the United States. It may well be the world's chief market, so far as

futures are concerned, though evidence to establish such a thesis is not

at hand. London and Liverpool are gigantic centres of commodity

speculation. But we have numerous cities in the United States where such

speculation is very great. St. Louis, Kansas City, Minneapolis, New

Orleans, and other cities are active speculative centres. New York,

while small in its volume of grain and produce speculation as compared

with Chicago, is the world's centre for cotton speculation, and the

world's centre for futures in coffee, though yielding precedence to

Havre, Santos and Hamburg,[276] ordinarily, in the volume of spot coffee

transactions, and though handling only a very small amount of spot

cotton. The volume of cotton sold in an ordinary year in New York is

50,000,000 bales,[277] though only about 160,000 bales are ordinarily

received there, in a year.[278] In the five years preceding 1909, the

sales on the New York Coffee Exchange averaged over 16 million bags of

250 pounds each.[279] In 1915, 32 million dollars were deposited as

margins in connection with this speculation in coffee, and in ordinary

years this runs from 25 to 30 millions, according to the Treasurer of

the Exchange. The relation between the margins put up and the total

pecuniary volume of trading is not indicated, but in most exchanges the

actual depositing of margins is a small fraction of the pecuniary

magnitude of the turnovers. Both the Cotton and the Coffee Exchanges are

international centres. The Coffee Exchange now handles large

transactions in sugar, also.

Contacts between the organized exchanges and ordinary business are very

numerous. Producers in every line who can do so protect themselves by

"hedging" in the exchanges which deal in their raw materials. This is a

commonplace, so far as millers are concerned. The writer has found

millers in a town off the main lines of the railroads in Missouri who

regularly sell short a bushel of wheat on the St. Louis Merchants'

Exchange for every bushel they buy to grind. The business man who does

not sometime take a "flier" in the market for other than hedging

purposes is rare! But, apart from the organized markets there is an

immense volume of speculation. If a wholesaler buys only what he can

sell to retailers, it is not speculation. But if he buys in excess of

the anticipated demands of his retailers, expecting to sell the excess

at an advance to other wholesalers, he is speculating. If a farmer buys

cattle to feed, he is not speculating, but if he buys them thinking to

sell them at an advance in a short time, and does so, the transactions

are speculative. The line is not easy to draw, in practice. Intention is

shifting and uncertain. There is chance in every industrial, commercial,

and agricultural operation. But for the point at hand, the test is

simple: do more exchanges take place than are necessary, under the

existing division of labor, to advance the materials of industry through

the stages of production, and get things finally to the consumer? If so,

the excess of exchanges is speculative. Trading between men in the same

stage of production is speculation. It represents trading to smooth out

dynamic changes, to bring about readjustments which would have been

unnecessary had conditions really been static, and had the initial plans

of enterprisers been adequate. Trading in anticipation of further

trading with men in the same stage of production is speculative. This

sort of thing, in the wholesale business, especially, is exceedingly

common. This has been noted by Professor Taussig, and made by him an

important point in the theory of crises. Dean Kinley[280] called

attention to it as a matter of importance in connection with his

investigation in 1896. The coming of cold storage, and the development

of the canning industry have, I am informed by a colleague in the

Harvard Business School, enormously increased this speculation among

both wholesalers and retailers, and it is very important in most

wholesale lines. There is short-selling in materials for construction

purposes, and in metals, apart from organized exchanges, and, where

possible, contractors in the building trade often protect themselves by

means of future contracts with speculators who are selling short.

Land speculation, in varying volume, is found in every part of the

country. There is speculation in leases, in options on real estate, and

in options on leases.[281] It may be noticed, too, that sales of

"rights," of puts and calls and straddles, and other contract rights,

are regular factors in the organized exchanges. Wherever profits are to

be made by leveling values as between different places or different

times, speculation arises, and, with dynamic change, this means

everywhere, in every business, and all the time! The shifting of labor

and capital from industry to industry, leveling returns to capital and

labor, involves an enormous amount of trading that would not occur in a

"normal equilibrium." Much of this the Stock Exchange does. That is what

it is for. But much of it has to do with unincorporated industry, and a

vast deal of speculative exchanging takes place to this end apart from

the organized exchanges.

Speculation in bills and notes, by note-brokers and particularly by

dealers in foreign exchange, occurs on a large scale, and accounts for a

great deal of the banking figures. This has nothing to do with

physically determined trade. From the standpoint of Professor Fisher's

"equation of exchange," it must be barred, if the contention that

"trade" is determined by "physical capacities and technique" is to be

adhered to. Speculation in demand finance bills is barred in any case,

since "money against checks," and "checks against checks," are excluded

by his definition.[282] But as an explanation of no small part of our

unexplained 245 billions of dollars, these items must be brought in.

They are "double counting" from the standpoint of Professor Fisher's

equation. They are, however, speculation. An official in a great New

York banking house, in charge of the foreign exchange department, writes

that in times when exchange rates are fluctuating, enormous quantities

of drafts on Europe will be bought and sold, during a period of a couple

of weeks or months, whereas under other conditions such transactions

might amount to little with the same volume of imports and exports. The

part of this which is between banks, a very big item, would not count in

the 245 billions, but to the extent that foreign exchange brokers

outside the banks participate, their activity helps to explain our 245

billions.

If it be true that speculation, including all manner of readjustment to

dynamic changes, makes up the overwhelming bulk of trade in the country,

then Fisher's _indicia_ of variation in trade, weighted as they are, are

totally misleading. The same is true of Kemmerer's _indicia_ of "growth

of business."[283] These are: population, tonnage entered and cleared,

exports and imports of merchandise, postal revenues, gross earnings of

railways, freights carried by railways, receipts of the Western Union

Co., consumption of pig iron, bituminous coal retained for consumption,

consumption of wheat, consumption of corn, consumption of cotton,

consumption of wool, consumption of wines and liquors, market values of

reported sales on the New York Stock Exchange. Only the last of these is

in any sense an index of speculation. It is swallowed up by being put on

a par with the other fourteen items. Its influence on the final index,

made by averaging the others is, as inspection shows, virtually _nil_.

Out of the twenty-six years his figures cover, the general index moves

counter to the share sales 14 times! Utterly random figures would have

come nearer to the facts in the case. It is particularly striking that

Professor Kemmerer, whose total figures, as Professor Fisher's, rest for

their absolute magnitude on Kinley's investigation,[284] should assign

89% of his estimated trade (183 billions in 1890) to wholesale

commodities,[285] (with 3% to wages, and 8% to securities), when

Kinley's figures show that wholesale deposits are a minor fraction of

the total!

The constancy in the figures of these two writers for trade from year to

year, a general steady, upward growth, does indeed suggest that trade is

determined "by physical capacities and technique," and that it does

stand as a great, independent, inflexible factor, independent of money

and deposits, constituting a real causal coefficient with them in

determining prices. If, however, speculation is as big a factor as our

analysis would indicate, then trade is a highly flexible thing, varying

enormously from year to year, moved by a multiplicity of causes, among

them _fluctuations_ in particular prices, and the ease and tightness in

the money market--the quantity of money and deposits.

But quite apart from speculation, it is not true that trade is a mere

matter of physical capacities and technique, a passive function of

production. Rather, one would almost have to reverse the relation.

Production waits on trade!

Production, as now carried on, is primarily conducted in the expectation

of _sale_, and of profitable sale. Trade does not go of itself,

automatically. Rather, it is a highly difficult matter, calling for the

highest order of ability, and the labor of innumerable men. In general,

I think it safe to say that in ordinary times, the manufacturer loses

vastly more sleep over the question of how he shall market his output,

than he does over the question of how he shall produce it. A clerk in

the Westinghouse Air Brake Company, engaged in the accounting

department, spoke recently to the writer of the "productive end" of the

business. On inquiry, it developed that he meant the selling department!

He stated that the manufacturing department also, in the language of the

employees, in that corporation, would also be termed "productive," but

that the selling department was _the_ productive department.

If one reflects a little as to the proportion of "costs" that go into

selling, as compared with technical "production," I think my point will

be clearer. Advertising has developed so enormously that it needs little

discussion. It has been stated that the "Sapolio" people once tried,

after their reputation seemed thoroughly established, to stop

advertising, with such disastrous results that very extraordinary

efforts were required to reestablish the brand. Number 2 wheat is not

advertised, in the great magazines, but innumerable brands of flour get

newspaper and magazine advertising,--some of them in such a periodical

as the _Saturday Evening Post_, and even those which are locally

consumed are commonly advertised in the local press. Nor is it only

finished products, of the sort that must be sold to the fickle public,

that involve these heavy selling costs. The writer has in mind a

corporation producing a high-grade type of glazed retort, in the

production of which it has virtually a monopoly, since the clay with

which it is made does not coexist with the skill to make it in any other

place. The particular product is an indispensable part of many important

technical processes. Substitutes made of other clays, and by other

companies, are known by the trade to be unsatisfactory. The buyers are

all highly trained business men. Here, if anywhere, selling costs should

be slight. But the chief selling agent of the corporation has found it

necessary, in order to keep the business going, to incur huge expenses

for entertaining his customers, finds it necessary to incur great

travelling expenses, to use only the most expensive hotels, and,

incidentally, to drink a great deal more than his personal inclinations

would call for, in keeping the business for his house. I waive

discussion of the extraordinary fees which a trust promotor makes, in

effecting a consolidation of big business units,--a process of exchange.

I am speaking now of the ordinary costs involved in ordinary trade. The

army of travelling salesmen, the body of stenographers, who write

letters, with various "follow-ups," in the effort to get more business,

the growing complexities of such letter writing, in which all suspicion

of "circularizing" must be allayed, one-cent stamps being absolutely

taboo!--these things are the commonplaces of business. They are in the

primers in the "commercial colleges" and "schools of commerce." Only the

orthodox economist, with his doctrine of the impossibility of general

overproduction, is ignorant of them!

This feature of modern business has been much elaborated in a recent

book which has not received the attention it merits--though its strength

is rather in criticism than in constructive doctrine. I refer to

Dibblee, _The Laws of Supply and Demand_.[286] Dibblee makes an

interesting contrast between commercial and manufacturing cities,

maintaining that the former necessarily outgrow the latter--a contention

which London, New York, Chicago and other places strikingly illustrate.

He presents a truly remarkable fact about London:[287] a recent report

of the Commission on London Traffic states that there were in London 638

factories registered as coming under the Factory Acts, with an average

horse-power of 54. The total power employed within the London area under

the Factory Acts, chiefly used in newspaper printing, was 34,750

horse-power--just one-half of what is required for the steamship,

Mauretania! This is the greatest city in the world. What do its millions

do for a living?[288] The town of Oldham,[289] he asserts, with 100,000

inhabitants, has spindle capacity enough to supply more than the regular

needs of the whole of Europe in the common counts of yarn. To _market_

the output of Lancashire, "the merchants and warehousemen of Manchester

and Liverpool, not to mention the marketing organization contained in

other Lancashire towns, have a greater capital employed than that

required in all the manufacturing industries of the cotton trade."

Accurate estimates of the proportion of "selling costs" to costs of

technical production are doubtless impossible, for the general field of

trade, and precision is unnecessary for my purposes. Dibblee's

conclusion, after contrasting retail and wholesale prices, and analyzing

the expenses incurred in selling prior to the wholesale stage, is that

the cost of marketing is at least equal to "real cost of production,"

occasionally only slightly below it, and often far above it (62).[290]

If one considers how large the item of "good will" often bulks in the

value of "going concerns"[291]--good will being in large degree often

just a capitalization of prior costs of this nature--Dibblee's estimate

need not be exaggerated. Trade connections, trade-marks that have

reputation, etc., often represent enormous output in thought, work, and

expense. Selling costs may, like other costs, be divided into "prime"

and "overhead" costs. Some of the latter lead to long-time consequences,

pay for themselves only in the long run. These may be "capitalized" in

"good will."[292] Of course, not all good will is got at a cost. Much of

it is adventitious.

In the light of the doctrine that trade is independent of money and

credit, one wonders why it should be thought necessary to extend

branches of American banks to the South American markets which we are

now reaching out toward. And why have Americans, from the beginning,

been constantly increasing commercial banks?[293] It is easy to sneer at

the efforts of the successive frontiers in our history to provide

themselves with banks of issue as based on a delusion, the delusion that

bank-notes are "capital," and to say that their real need was, not more

bank-credit, but more real capital. They needed more tools and

live-stock, doubtless, but is that the whole story? And were their banks

of no assistance in getting the additional capital of various sorts? And

was it a matter of no consequence that they had an abundant medium of

exchange? It seems almost childish to put such questions, but the

quantity theory has as its logical corollary that to multiply banks is

quite useless and wasteful, since the only result is to raise prices. If

increasing bank-credit cannot increase trade or production, this

corollary is inevitable. Indeed, the case may be more strongly stated.

Quite apart from the wasted labor of bank-clerks and the waste of

banking capital, the effect of increasing bank-development, on quantity

theory reasoning, is harmful. If increasing bank-credit is to raise

prices without increasing trade, then, on quantity theory reasoning, it

must _depress_ business. The reason is that rising prices in a given

region make that region a bad place to buy in, and so curtail its

exports. This is, indeed, the quantity theory explanation of

international trade, to which attention is later to be given. The

country which is expanding its banking facilities most rapidly will

suffer most in competition in the world markets. This is why the United

States have so little foreign trade! It also explains the rapid strides

that China and Central Africa have recently made in capturing the

world's markets. I submit that there is no flaw in this argument, if the

premise of the independence of volume of trade and volume of bank-credit

be granted. It follows from the quantity theory. That it is no

caricature of Fisher's argument will appear, I think, from the following

quotation,[294] which very nearly states what I have just been saying,

though it does not draw the conclusion that banking is a bad thing: "The

invention of banking has made deposit currency possible, and its

adoption has undoubtedly led to a great increase in deposits and

consequent rise in prices. Even in the last decade the extension in the

United States of deposit banking has been an exceedingly powerful

influence in that direction. In Europe deposit banking is in its

infancy."[295] Happy Europe, troubled only by war! It is greatly to be

hoped, in the interests of American agriculture, that the efforts to

increase agricultural credit facilities will fail!

We are driven to one of the most fundamental contrasts in economic

theory, which appears under various guises and in different forms:

statics _vs._ dynamics; transition _vs._ equilibrium, theory of

prosperity _vs._ theory of goods; normal tendency _vs._ "friction."[296]

Perhaps Professor Fisher, and the quantity theorist in general, would

dismiss many of these considerations as not applicable to the general

principle, which is a "normal" or "static" or "long run" law, not

subject to considerations of this sort. It is scarcely open to Fisher to

defend himself this way, because of his exceedingly uncompromising

statement regarding even "transitional" relations between volume of

trade and money and credit. I shall not reply to anyone who offers such

an objection by a general tirade against "static economics." I believe

thoroughly in the method of economic abstraction, and in reaching

general principles by ignoring, provisionally, in thought the "friction"

and "disturbing tendencies" which often make the first approximations

look somewhat unreal. But I raise this question: to what feature of our

economic order do we chiefly owe it that we can make such abstractions?

By virtue of what does friction disappear? What is it that makes our

abstract picture of economic life, as a fluid equilibrium, with its nice

marginal adjustments, its timeless logical relations, correspond as

closely as it does to reality? The answer is: MONEY and CREDIT.[297]

It is the _business_, the _function_, of money and credit, as

instruments of exchange, to bring about the fluid market, to overcome

friction, to effect rapid readjustments, to give verisimilitude to the

static theory, to make the assumptions of the static theory come true.

Where exchange is easy and friction slight, there will not be two prices

for the same good in the same market. Speculators, seeking profits of

fractions of a point, will prevent that. By multiplying exchanges, they

will level off values and prices. Because money and credit have done

their work so thoroughly in the "great market," it is possible for men

to talk about static theory, and to work out economic laws in

abstraction from friction, transitions, and the like.

In the static state, all speculation is banished. There are no

price-fluctuations to be smoothed out, no new prospects to be

"discounted," no uncertainties to be guarded against by "hedging."

Seasonal goods will, of course, have to be carried over from one season

to the next, but this will involve merely warehousing and the use of

capital--"time speculation," involving many sales, does not come in. One

sale to the capitalist who carries the seasonal goods, with a sale by

him to the man who means to use them, will suffice. It has been shown

before that the great bulk of trade is speculation. But speculation is

banished from the static state. Speculation is a function of dynamic

change, waxing and waning with the degree of uncertainty that exists,

the new conditions to which readjustments have to be made, the

"transitions" that have to be effected. In other words, the laws

governing the volume of trade are dynamic laws, laws of "transition

periods," and so the whole notion which underlies the quantity theory,

of "normal periods," "static" relations, etc., is here irrelevant.

Volume of _trade_, as distinguished from volume of _production_, is

controlled by the number and extent of the "transitions" that have to be

made. The chief work of money and credit is done _in_, and _because of_,

"transition periods." Assume a normal equilibrium accomplished, and you

have little trading left to do. It will still be necessary, if you have

the division of labor, and private enterprise, for goods to pass through

as many different hands as there are different independent enterprisers

in the stages of production, and on, through merchants, to the consumer.

It will still be necessary to pay wages, rents, dividends and interest.

But there will be no selling of lands, of houses, of factories, of

railroads, or of securities representing these. By hypothesis these are

already in the hands best qualified to hold them. The "static

equilibrium" presents "mobility without motion, fluidity without

flow."[298] The static picture is a picture of completed adjustment,

where no one has an incentive to change his work, or his investments,

because he has already done the best that he can for himself. It is,

therefore, a picture of a situation where there is little incentive for

those exchanges which make up the great bulk of the volume of trade in

real life.

Hence the curious phenomenon that very much of static theory has been

developed in abstraction from _money_ and _credit_. Mill's theory of

international values, for example, abstracts from money. "Since all

trade is in reality barter, money being a mere instrument for exchanging

things against one another, we will, for simplicity, begin by supposing

the international trade to be in form, what it is in reality, an actual

trucking of one commodity against another. So far as we have hitherto

proceeded, we have found the laws of interchange to be essentially the

same, whether money is used or not; money never governing, but always

obeying, those general laws."[299] Other writers have similarly held

that money is a mere cloak, covering up the reality of the economic

process. Schumpeter, for example, holds that money is, in the static

analysis, merely a "Schleier," and that "man nichts Wesentliches

uebersicht, wenn man davon abstrahiert."[300] _On the static

assumptions_, of the fluid market, with friction, etc., banished, money

is, indeed, anomalous and inexplicable. It is a cloak, a complication, a

vexatious "epi-phenomenon." There is nothing for it to do, and there can

be, consequently, no "functional theory" developed for it. Static theory

may be ungracious in ignoring its own foundation. But static theory is

grotesque when it seeks to support its own foundation! Static theory is

possible only on the assumption that the work of money and credit has

been done. What, then, shall we say of static theory which seeks to

explain the work of money and credit? Yet precisely this is what is

undertaken by the quantity theory, with its "normal" or "static" laws of

money and credit. A functional theory of money and credit must be a

dynamic theory. To talk about the laws of money, "after the transition

is completed" is to talk about the work money will do after it has

finished working. For a functional theory of money and credit, we must

study the obstacles that exist to prevent the fluid market. We must

study friction, transitions, dynamic phenomena.

To this problem we shall come in Part III. For the present, I am content

to have disproved the quantity theory contention that the volume of

trade is independent of the quantity of money and credit.

APPENDIX TO CHAPTER XIII

THE RELATION OF FOREIGN TO DOMESTIC TRADE IN THE UNITED STATES[301]

The word, "trade," as used in connection with statistics of foreign and

domestic trade has been irritatingly ambiguous. Few writers, in speaking

of domestic trade, have meant the same thing by trade that they have

meant by the word when speaking of foreign trade, and hence we have had

many pointless efforts to institute comparisons between the two, and

some very misleading statements about the matter. Thus, figures have

been offered which would show that the foreign trade of the United

States is only a fraction of 1% of the domestic trade. This conclusion

is reached by taking the figures for banking transactions discussed in

Chapters XIII and XIX as representative of domestic trade, and comparing

them with the annual figures for exports and imports. This procedure is

fallacious for several reasons:[302] the figures thus reached for

domestic trade exceed even the total trading within the country, as

shown in Chapter XIX. In the second place, as shown in Chapter XIII, the

bulk even of these deposits which do represent real trading grow chiefly

out of speculation. Even in ordinary trade, goods are counted several

times before reaching the final consumer. It is clear, therefore, that

even an accurate figure for total trading within the country would have

little relevance when we are seeking a figure to compare with exports

and imports. Nor, if a comparison of the actual trading in which

foreigners participate with the trading exclusively between Americans is

sought, can we take the export and import figures as representative of

the foreign trading--they do not include a multitude of highly important

transactions in which foreigners participate. Very much of the business

of the New York Cotton Exchange, the New York Stock Exchange, the

Chicago Board of Trade, and other speculative markets represents foreign

buying and selling, especially arbitraging transactions, and the other

"invisible items" of foreign trade need merely to be mentioned for the

economist to recognize the fallacy of a comparison which omits them.

What figures are relevant when we wish to compare foreign and domestic

trade? First we must make clear the purpose for which the comparison is

to be made. If we are concerned with the calls made by foreign and

domestic trade on the money market, we should make use of a different

method of comparison than that which will be here employed. The purpose

of the comparison here undertaken is to determine how much of our

American labor, land and capital is at work producing for the foreign

consumer, as compared with the land, labor and capital in America

producing for the American consumer. The comparison here undertaken is

concerned with the question which is usually uppermost in the minds of

those who undertake such a comparison, namely, _how important_ is our

foreign market to us? Obviously, for such a comparison as this, we

should not count a given case of eggs twelve times merely because it

changed ownership twelve times in getting from farm to breakfast table.

Items of export and import count only _once_ in the figures for export

and import. We must find a figure for domestic "trade" in which items

count only once, allowing no turnovers of the same goods to swell the

total, if we wish to make our figures comparable.

The method proposed for making this comparison, for a long series of

years, is a modification of the method used by the writer in an article

in the _Annalist_ of Feb. 7, 1916. A figure based on the bank deposits

of _retail merchants_ in Kinley's 1909 investigation was there taken as

properly comparable with the export and import figures. The final sale

to consumer by retailer is "the one far off divine event" toward which

the whole productive process moves. Everything else in production and

exchange looks forward to this. Ultimately, from the demand of the final

consumer comes all the demand that is directed toward the agencies of

production, even though the laborer sees his immediate market in the

person of the employer, and the capitalist or landlord sees his

immediate market in the person of the active business man. The figure

reached for retail trade by the method then employed was $34,500,000,000

for 1909. This figure was too high, as shown in Chapter XIII above, and

the figure reached now for retail _deposits_ by the same method is

$32,000,000,000. Even this figure is too high, however, as I there

concluded, to represent retail _trade_, and I shall use it only as a

check on King's figure for _the total income of the United States in

1910_, which I shall use as a base figure instead of my own. King's

figure for the total income of the United States in 1910 is

$30,500,000,000.[303] I take this figure as including all that the

American people spend for consumption, with retailers, physicians,

hotels, theatres, etc., and also their net savings for the year. Part of

this they spent for foreign products. The rest they spent at home. This

residue spent at home gives us a figure which we may properly compare

with the amount the foreigner spends in America, as indicating the ratio

of foreign to domestic trade for the purpose in hand. We subtract, in

other words, from the figure for total income the figure for _imports_.

Then we compare the residue with the figure for _exports_, and get our

ratio of foreign to domestic trade. The export and import figures must

first, however, be reduced to a _retail_ basis. That is, assuming that

wholesale prices are two-thirds of retail prices, we add 50% to the

figures for exports and imports (which are wholesale figures) before

making the subtraction and the comparison. The ultimate consumer, both

in Europe and America, pays for imports and exports on a _retail_

basis.[304] This method, applied to the figures for 1910, gives us a

ratio of about 10:1 for domestic to foreign trade--the lowest percentage

for foreign trade which we shall find for any year in the period

investigated, 1890-1916.

This comparison is still unfavorable to foreign trade. Domestic trade,

in our figures, includes savings and investments, including investments

made by Americans abroad. Import figures are marred by undervaluations,

exports are not all counted, and the figures for exports and imports do

not include foreign investments in America. American investments abroad

should not be counted as part of domestic trade. Moreover, our figures

take no account of travellers' expenditures, or of services performed by

professional men of one country for men in another, or of certain other

"invisible items." But while this makes our percentage for foreign trade

too low for all years, it probably does not greatly upset the results

for yearly variations in the ratio except for the year 1916, when the

figure for domestic trade is left decidedly too high, and the ratio for

foreign trade is too low, as compared with previous years.

For years other than 1910, indirect calculations must be resorted to for

domestic trade. I have substantial confidence in the rough accuracy of

the figure chosen for 1910 in view of the convergence of two widely

different sets of data. My figure for retail deposits in 1909 is

$32,000,000,000. King's figure for total income is $30,500,000,000 for

1910. King's figure seems to me a better figure to use for the purpose

in hand. I use my own merely as a rough check on his. For years other

than 1910, the figure for net income is calculated as a percentage of

King's figure for 1910, by means of an "index of variation." It is

assumed that the net income of 1905, for example, bears the same

relation to the index for 1905 that the absolute figure for net income

of 1910 bears to the index for 1910, and net income for 1905 is then

computed by "the rule of three." The index of variation chosen is

_railway gross receipts_ weighted by _wholesale prices_. I think that

railway gross receipts are, on the whole, the most dependable and easily

manageable index of physical volume of production that we have, though

recognizing difficulties, later to be discussed, in using them for the

purpose in hand. Railroads touch virtually every kind of business in the

country. Variations in the _pecuniary_ volume of production and

consumption, however, if due to rising or falling _prices_, rather than

to changing physical volume, would not be indicated by changes in

railway gross receipts. The same volume of transportation might

represent widely varying pecuniary values of goods transported. Railway

rates do not vary from year to year with prices of goods, even though

high-priced goods are normally charged higher rates than low-priced

goods. The index, therefore, must include _prices_ as well as physical

volume of transportation. For 1910, therefore, railway gross receipts

and an index of prices are multiplied together, and counted as 100%. The

same thing is done for railway gross receipts and prices for other

years, and the results reduced to percentages of the result for 1910.

The figure for net income in any other year is then readily computed as

a percentage of the figure for 1910. The results, for the years

1890-1916, appear in the tables below.[305]

It may be noticed that my figures for net income in 1900 and 1890 do

not correspond very closely with the figures for the same years as

independently estimated by King. My figure for 1900 is $12,900,000,000,

where his is $17,965,000,000; for 1890, my figure is $9,300,000,000,

where his is $12,082,000,000. I am inclined to the view that the figures

in my tables come closer to the facts for these years than do his

figures, assuming that _his figure_ for 1910 is correct. It will be

noticed that on his figures there was an increase of about 50% from 1890

to 1900, and an increase of only about 66% in the decade following. This

seems to be an unlikely relation. One would expect a much greater rate

of increase for the decade 1900-10, as compared with the preceding

decade, than King's figures show. The period from 1890 to 1900 included

the terrible panic of 1893 and the prolonged depression ensuing. The

panic in 1907 was trifling in comparison, and recovery, as shown by our

index numbers in the tables below, was very much quicker. Moreover,

falling prices characterized much of the earlier decade. The highest

prices of the whole ten years were in 1891. The period from 1900 to 1910

is a period of rapidly rising prices, on the whole. On the basis of our

general knowledge of the two periods, one would expect a greater

percentage gain by far for the second decade, and I therefore trust the

results of the index of variation here chosen, which show that. Similar

results are obtained by applying to the base figure for 1910 an index

of variation derived from Kemmerer's and Fisher's figures for trade[306]

and prices. My figure for 1890 may, moreover, be checked by comparison

with the figure given by C. B. Spahr in _The Present Distribution of

Wealth in the United States_ (p. 105) for the net income of the country

for that year: $10,800,000,000. It may be that my figure for 1890 is too

low, but I have not sought to "doctor" it by an arbitrary "correction

factor" to make it correspond more closely than it does with the other

estimates. It is striking enough that a figure derived from an index of

variation, twenty years away from its base, should come as close as this

to figures calculated from wholly different data.

One brief comment may be made on the significance of these figures. It

may be questioned if figures showing the proportions of our industry

devoted to supplying goods for the foreign market correctly indicate the

importance of the foreign market to us. It may be urged that if we

should lose our foreign market, we should merely turn to producing more

for the domestic market, and that the loss would not be the whole of our

receipts from foreign trade, but merely the cost of transition, and the

loss that comes from shifting to production to which we are less suited.

This is, doubtless, true. But the loss reckoned this way may well be

greater than the loss reckoned on the basis of my figures! It is equally

true, moreover, that our domestic trade is not important to the extent

indicated by my figures, since if we lose part of our domestic trade,

our producers will turn to supplying more for the foreign market. But

one must not regard the cost of transition as a negligible matter! The

cost may easily be prolonged depression. Certain parts of our foreign

trade are really vital to us, both on the import and (to a less degree)

on the export side. The most important practical use to which the

figures here given may be put are in connection with short-run problems.

Foreign trade is so important to us that any sudden alteration in its

amount may bring great adversity or great prosperity--as the course of

the present War abundantly testifies.[307]

An application of our method to the years 1850 and 1860 gives a

percentage for foreign trade of 12.7 in 1850, and 16.0 in 1860.[308]

Certain other cautions are needed in presenting these figures. For one

thing, variations in railway rates will make a given volume of gross

earnings mean different things in different years as to the physical

volume of traffic. In the writer's opinion, which is confirmed by

Professor W. Z. Ripley, there is no possible way of making allowance for

this, as the cross-currents affecting railway rates are altogether too

numerous and obscure. Nor has any effort been made to allow for

variations in the proportions of freight and passenger receipts, or of

different classes of freight traffic.

Again, the proportions of railway traffic connected with foreign trade

may vary greatly, and it may happen that a big increase in railway gross

receipts is due to increasing foreign trade, primarily. There is reason

to suppose that much of the increase of 1916 is to be explained that

way. This makes our comparison for 1916 particularly adverse to foreign

trade, since we count as domestic trade what is really foreign trade.

The figures, however, are presented as they stand. Moreover, for 1916,

the great increase in foreign trade is in _exports_. Merchandise imports

are not much greater than in previous years.[309] Our exports have been

chiefly paid for by "invisible items," gold and securities, and short

term credits. These do not appear anywhere in our figures. A substantial

source of error appears from this cause in our 1916 figure. I should

think it safe to put the ratio for foreign trade to domestic trade for

1916 at above 20%, instead of the 17.9% our table shows.

The reader will wish to know for a given year how much of the increase

or decrease is due to physical growth of business, as represented by

railway gross receipts, and how much is due to changes in prices. To

give this information, and to make it easy for a critic to check the

results, a table showing the index numbers from which the figures for

net income are computed is subjoined.[310]

TABLE I[311]

1 2 3 4

Ratio of

Domestic Trade of Foreign Trade of Foreign

Calendar Net Income United States = United States = to

Years of the Net Income minus Exports at Retail Domestic

United Imports at Retail Prices Trade

States Prices

1890 $ 9,300,000,000 $ 8,100,000,000 $1,300,000,000 16.1%

1891 10,400,000,000 9,200,000,000 1,400,000,000 15.2%

1892 10,000,000,000 8,700,000,000 1,400,000,000 16.1%

1893 10,100,000,000 8,900,000,000 1,300,000,000 14.6%

1894 8,300,000,000 7,300,000,000 1,200,000,000 16.5%

1895 8,400,000,000 7,200,000,000 1,200,000,000 16.7%

1896 7,900,000,000 6,900,000,000 1,500,000,000 21.8%

1897 8,000,000,000 6,900,000,000 1,600,000,000 23.2%

1898 9,100,000,000 8,200,000,000 1,900,000,000 23.2%

1899 10,900,000,000 9,700,000,000 1,900,000,000 19.6%

1900 12,900,000,000 11,700,000,000 2,200,000,000 18.8%

1901 14,600,000,000 13,300,000,000 2,200,000,000 16.5%

1902 15,600,000,000 14,200,000,000 2,000,000,000 14.1%

1903 17,700,000,000 16,200,000,000 2,200,000,000 13.6%

1904 18,000,000,000 16,500,000,000 2,200,000,000 13.3%

1905 19,600,000,000 17,800,000,000 2,400,000,000 13.5%

1906 21,500,000,000 19,500,000,000 2,700,000,000 13.8%

1907 26,600,000,000 24,500,000,000 2,900,000,000 11.8%

1908 23,000,000,000 21,300,000,000 2,600,000,000 12.2%

1909 27,600,000,000 25,400,000,060 2,600,000,000 10.2%

1910 30,500,000,000 28,200,000,060 2,800,000,000 9.9%

1911 29,600,000,000 27,300,000,000 3,100,000,000 11.4%

1912 33,800,000,000 31,100,000,000 3,600,000,000 11.6%

1913 34,800,000,000 32,100,000,000 3,700,000,000 11.5%

1914 32,600,000,000 29,900,000,000 3,200,000,000 10.7%

1915 35,400,000,000 32,700,000,000 5,300,000,000 16.4%

1916 49,200,000,000 45,800,000,000 8,200,000,000 17.9%

TABLE II. INDEX NUMBERS FROM WHICH THE FIGURES FOR

NET INCOME ARE DERIVED

1 2 3 4

Composite Net Income[312]

Dun's Prices R. R. Gross Index, R. R. Gr. of the United

Calendar with base Receipts, Rcts. multiplied States in

Years in 1910 reduced to by Prices. billions of

base of (Column 1 x dollars:

1910 column 2.) 100:30.5::(3):$

1890 76.5 39.8 30.8 $ 9.3 billions

1891 81.5 42.0 34.2 10.4

1892 75.6 43.5 32.8 10.0

1893 77.3 42.9 33.2 10.1

1894 71.5 38.1 27.2 8.3

1895 68.0 40.7 27.8 8.4

1896 63.8 40.6 25.9 7.9

1897 62.2 42.4 26.4 8.0

1898 66.4 45.1 29.9 9.1

1899 72.3 49.6 35.8 10.9

1900 78.1 54.0 42.1 12.9

1901 80.6 59.4 47.8 14.6

1902 84.0 62.6 51.3 15.6

1903 83.1 70.1 58.2 17.7

1904 84.0 70.3 59.0 18.0

1905 84.0 76.4 64.2 19.6

1906 88.1 85.0 70.5 21.5

1907 94.0 92.9 86.3 26.6

1908 92.4 81.8 75.6 23.0

1909 99.0 91.7 91.0 27.6

1910 100.0 100.0 100.0 30.5

1911 98.1 99.0 97.0 29.6

1912 104.1 106.9 111.0 33.8

1913 101.7 112.5 114.0 34.8

1914 102.5 104.5 107.0 32.6

1915 106.0 110.0 116.0 35.4

1916 125.0 129.0 161.2 49.2

CHAPTER XIV

THE VOLUME OF TRADE AND THE VOLUME OF MONEY AND CREDIT

In the argument so far I have said nothing of the reverse relationship,

the dependence of the volume of money and the volume of credit on trade.

The two are indeed _inter_dependent. Interdependence suggests circular

theory, and is often a phrase to cover circular reasoning.[313] In the

case of the relation under discussion, however, I have, I trust, already

abundantly protected myself against the charge of circular reasoning by

_denying_ that either volume of money and credit on the one hand, or

volume of trade on the other hand, is a true cause at all. Both are mere

abstract names, designating highly heterogeneous individual occurrences,

which, _individually_ are cause or effect. In general, both volume of

money and credit, on the one hand, and volume of trade on the other

hand, are results of common causes, which are the _verae causae_ of

economic phenomena--values, psychological phenomena. The whole thing is

to be explained immediately and primarily in terms of social

relationships and mental processes,--in terms of social values.

To show that increasing trade tends to increase money and credit is not

difficult. If one may venture a hypothetical illustration--and the sort

of hypothetical illustrations, like the dodo-bone case, of which

quantity theorists are fond make one hesitate to do so--let us assume a

communistic community, isolated from other markets, with a developed

system of production, including an extensive use of gold in the arts.

Let the communistic regime gradually pass over to an individualistic

regime. Assume that the inhabitants are acquainted with the use of gold

as money, and that their government is willing to coin it freely. As

individualism spreads, and trade grows, will not more and more gold be

taken to the mints? I am not here concerned with the principles

determining the apportionment of gold between the money employment and

the arts. It is enough to show that expanding trade tends to increase

the volume of money.

Assume that the money supply meets difficulties in its expansion. Is

there not at once an incentive to extend credit? The seller finds his

customers unwilling to buy for cash, in amounts as great as before. In

order to sell as much as before (assuming that the use of credit is

known, to avoid trouble with historical origins), he extends

credit,--which, when practiced generally, lightens the strain on the

money supply.

I have so far said nothing of the case where there are stocks of the

money metal to be got from outside markets. But if a country is

expanding its trade, does not money come in? The quantity theorists

would, indeed, admit this, in general, though their reason is a bad one,

namely: that expanding trade lowers prices, and lower prices make the

market attractive to foreign buyers, who then send in money for the

goods. I shall later discuss this aspect of the theory.[314] For the

present, I merely interject the question as to the probability of an

expansion of trade when prices are falling. Increasing _stocks_ of

particular goods may well mean lower prices for these goods and if they

be articles of export the lower prices may well increase the export

trade, and bring money in. But this increase in _stocks_ of articles of

_export_ is very different from total _trade_ within the country; and

lower prices in articles of export are very different from a generally

lower price-level.[315]

Will expanding trade in a country increase credit? I come here to one of

the striking features of Fisher's doctrine--a feature in which I think

he is fundamentally true to the quantity theory. He finds no way in

which expanding trade can directly increase credit. Expanding trade can

increase credit, (a) only by changing the habits of the people, so as to

alter the ratio, M to M', or (b) by reducing the price-level, and so

bringing in money from abroad, whence, as M is now increased, M' rises

proportionately. "An increase in the volume of trade in any one country,

say the United States, ultimately increases the money in circulation

(M). In no other way could there be avoided a depression in the

price-level in the United States as compared with foreign countries. [He

should say, from the standpoint of his theory, that increasing trade

will cause a fall in the price-level, and so bring in more money.] _The

increase in M brings about a proportionate increase in M'._[316] Besides

this effect, the increase in trade undoubtedly has some effect in

modifying the habits of the community with regard to the _proportion_ of

check and cash transactions, and so tends somewhat to increase M'

relatively to M; as a country grows more commercial the need for the use

of checks is more strikingly felt."[317] In a footnote to this

paragraph, he defines the issue still more sharply. "This is very far

from asserting as Laughlin does that 'The limit to the increase in

legitimate credit operations is always expansible with the increase in

the actual movement of goods'; see _Principles of Money_,[318] New York

(Scribner), 1903, p. 82. We have seen, in Chapter IV, that deposit

currency is proportional to the amount of money; a change in trade may

indirectly, _i. e._, by changing the _habits_ of the community,

influence the proportion, but, except for transition periods, it cannot

influence it directly."[319]

My own explanation of the causal sequence whereby expanding trade brings

money into a country would be radically different from that given by

Fisher in the first quotation. I should expect, first, that rising

_prices_ would encourage rising trade; I should then expect the rising

volume of trade, with higher prices, to lead borrowers to need, and

secure, larger loans from the banks, with, as loans and deposits rise in

proportion to reserves, some slight increase in "money-rates," just

enough to draw to the country the extra gold which bankers felt

desirable to add to their reserves. I should expect the causal sequence

to be the exact reverse of that which Fisher indicates. With falling

prices, or waning volume of trade--which would usually come

together,[320]--I should expect loans to be reduced, deposits to be

reduced, money-rates to fall, and gold then to leave the country again.

I should expect this sort of thing to happen normally, and not

infrequently, and I should expect gold to come in and go out many times

in the course of a business cycle. This would seem to be the sort of

explanation which our modern theory of _elastic_ bank-credit would give

in connection with this problem. I shall not here go into details with

the theory of elastic bank-credit. The theory has been too well

established in the debates between the "Currency School" and the

"Banking School"[321] in regard to bank-notes to need elaboration and

defence here, and the essential identity of deposits and elastic

bank-notes from this angle is one of the commonplaces of the literature

of banking. What I am here concerned with is the highly significant fact

that Fisher's "normal" theory finds no place for this highly important

phenomenon. The quantity theory has no explanation of elasticity to

give. On the basis of the quantity theory, and for all that the quantity

theory can say, the Currency School was right! Fisher offers us,

virtually, a "currency theory" of deposits. "Suppose, as has actually

been the case in recent years, that the ratio of M' to M increases in

the United States. If the magnitudes in the equations of exchange in

other countries with which the United States is connected by trade are

constant, the ultimate effect on M is to make it less than what it would

otherwise have been, by increasing the exports of gold from the United

States or reducing the imports. In no other way can the price-level of

the United States be prevented from rising above that of other nations

in which we have assumed this level and the other magnitudes in the

equation of exchange to be quiescent." (P. 162.) If "bank-notes" be

substituted for "M'", in this quotation, we have here a perfect

statement of the position of the "Currency School" in that great debate.

Must this old issue be fought all over again? And yet, I defy any

consistent quantity theorist to find any flaw in Fisher's argument on

this point. There is no place for a theory of elastic bank-credit

within the confines of the quantity theory. Fisher's recognition of this

seems full and complete. He relegates all mention of elastic bank-credit

to "transitions." The footnote quoted above, in which Laughlin's

(somewhat extreme) doctrine based on the theory of elasticity is stated,

denies categorically that there is any validity in it, except for

transition periods. There is nowhere in the book any explanation of the

theory of elasticity.[322] The references to it are few and grudging,

and _always_ in connection with the notion of transitions. The most

important statement regarding elasticity (less than a page long) is on

page 161, where again transitional influences are under discussion. What

is a theory of money worth which can offer no explanation of so

fundamental, important, and notorious a feature of modern money and

banking?

There is a further, related, feature of banking for which the quantity

theory can find no explanation. Among the items in a bank's balance

sheet, the quantity theorist seizes upon reserves on the assets side,

and deposits on the liability side, and builds his theory on the

supposed close relation between them. We have seen that this close

relation does not, in fact, exist. The range of variation is

enormous.[323] But there is one close relation in the balance sheet of

the bank concerning which the quantity theory is silent, and that is the

relation between deposits and _loans_. For individual banks and for

banks in the aggregate, for long run periods and for short run periods,

for reasons that are clear and inevitable, these two magnitudes (or for

banks of issue on the Continent of Europe, _notes_ and loans), vary

closely together. The relationship between them is the only relationship

which does stand out as clearly beyond dispute, among all the items in

the banking balance sheet. No assumptions of a "static state" are needed

for its demonstration! The relation varies, of course. As banks increase

or reduce their capital, as their reserve-percentages rise or fall, as

they increase or decrease their holdings of bonds, we find reasons which

alter the proportion between deposits and loans. But, despite this, the

variation, as shown by figures for the United States, is slight. Assume,

for example, a statement showing "loans and discounts" of $1,000,000,

deposits, $1,000,000, cash reserve, $200,000. Reserves are then 20% of

deposits, and loans are 100% of deposits. If reserves be increased by

$100,000 and loans and discounts reduced, to compensate, by $100,000, we

have a 50% variation in the ratio of reserves to deposits, with only a

10% variation in the ratio of loans and discounts to deposits. Since

cash reserve is much the smaller item, almost always, the same absolute

variation in it will affect it, in percentage, vastly more than it will

affect loans and discounts. It is strange that a theory should seize on

this highly variable ratio of reserves to deposits, and ignore the much

more constant ratio[324] of loans and discounts to deposits.

That this close relation between deposits and loans should obtain

follows naturally from the theory of elastic bank-credit. The two are

built up together. When there are expanding business and rising prices,

men borrow more from the banks; as they borrow, they receive deposit

credits; the individual who receives the deposit credit may check

against it, but it is redeposited by another man, and so, while the

deposits of one bank need not grow out of its loans, still, for banks in

general, deposits are large because loans are large. For a given bank,

the relation holds closely, because the bank lends, in general, to

active business men, who will have income as well as outgo, and whose

income will, on the average, at least balance their outgo. Thus,

_through loans_, deposits are linked with volume of trade and prices.

Trade and deposits wax and wane together.[325] On the other hand, in the

absence of rising prices and increasing trade, reserves may increase

greatly without forcing an increase in deposits. Loans cannot increase

without an increase in deposits. The linkage between deposits and trade

is definite, causal, positive, statistically demonstrable. The linkage

between reserves and deposits is, at most, negative--if reserves get too

low, deposits and loans may be checked in their expansion. But this--to

the extent that it is true, which we leave, for detailed analysis, for

Part III--gives a very much looser relation indeed than the direct

relation between loans and deposits.

The quantity theory has offered no explanation of this relation between

loans and deposits. What explanation could a theory offer, which rests

in the notion that volume of trade on the one hand, and volume of money

and bank-credit on the other hand, are independent magnitudes?[326] I do

not mean that quantity _theorists_ are silent regarding the relation of

loans and deposits. I mean that they do not attempt, in any discussion I

have found, to apply the quantity _theory_ to the explanation of that

relation. What shall we say of a theory which, ignoring these easily

proved, easily explained, and vital facts regarding bank-credit, offers

as its sole explanation of volume of bank-credit a theory so untenable

as that of a fixed ratio between volume of bank-credit and volume of

money _in circulation_, with causation running from money to deposits?

Professor Fisher says little about bills of exchange. Here, surely, we

have a credit instrument which grows directly out of trade, in general,

and whose volume expands and contracts with trade. When banks discount

bills of exchange, and issue notes, or grant deposit credits, against

such discounted bills, the connection of bank-credit and volume of trade

is obvious. The same thing holds largely, however, when promissory notes

are discounted. Such notes are usually given by those who plan to use

the credits granted in commercial or speculative transactions. The bill

of exchange differs from the promissory note in practice, however, in

that it itself is often a medium of exchange, without going into the

bank's portfolio. "The bill of exchange, therefore, before it gets to

the bank _usually_[327] performs a series of monetary transfers, for the

small dealer naturally prefers to pass on the bill, if possible, in

making a payment, instead of handing it over to his bank, which would

either deduct a certain percentage in the way of discount, or else

accept the bill at its face value, crediting the customer with the

amount on the date of maturity, while business men (other than bankers)

are in the habit of taking bills of exchange as they would cash."[328]

This quotation describes conditions in Germany. The same authorities (p.

176) give figures showing a rapid development in the volume of bills of

exchange, rising from about 13 billions of marks in 1872 to about 31

billions in 1907. These figures show that bills of exchange are a big

factor in German business life,--a conclusion that is strengthened when

they are compared with the figures for giro-transfers on pp. 188-189 of

the same article, or with the figures for note issue on p. 209.[329] In

the United States, of course, the use of bills of exchange has become

comparatively unimportant in domestic commerce,[330] though there is a

movement to revive them, since the new Federal Reserve system has come

in. Their chief importance is in connection with foreign trade. Is it

possible that Professor Fisher's reason for wishing to minimize foreign

trade[331] is the unconscious desire to get rid of the annoying bills

of exchange, which so obviously tend to make bank-credit and volume of

trade interdependent, and which further spoil the quantity theory by

serving as a flexible substitute for both money and deposits?

I regret the necessity for this elementary exposition of familiar

things. But Fisher's theory has no place for these familiar things--and

Fisher has merely made very explicit the logic of the quantity theory!

As applied to modern conditions, the quantity theory is obliged to

assert--and Fisher does assert:

(a) that there is a causal dependence of bank-credit on money,

and "normally" a fixed ratio between them;

(b) that velocity of circulation of money and credit

instruments are independent of quantity of money and credit

instruments;

(c) that, in general, money and volume of credit (taken

together), velocities, and trade, are independent magnitudes,

each governed by separate laws, though Fisher concedes _some_

reaction of trade on velocities;

(d) in particular, that volume of money and credit has no

influence on trade, and that trade has no direct influence on

volume of credit.

All these doctrines are necessary if the contention that an

increase of money will proportionately raise prices is to be

maintained, or if it is to be maintained that a decrease in

trade will proportionately raise prices. I have analyzed each

of these contentions, and I find justification for none of

them.

Not yet, however, have we reached the least tenable aspect of the

quantity theory. There remains the contention that prices are passive,

that a change, _originating_ in prices, and involving a change in the

average price, or the general price-level, cannot maintain itself--that

P is a passive function of the other five magnitudes of the equation of

exchange. To this central fortress of the quantity theory we shall

devote the next chapter.

CHAPTER XV

THE QUANTITY THEORY: THE "PASSIVENESS OF PRICES"

Is the price-level passive? Is it true that while change may occur from

causes outside the equation of exchange in volume of money, volume of

trade, and velocities of circulation, a change in the price-level from

causes outside the equation is impossible? Must the average of prices be

a passive function of M, the V's, M' and T? Such is the general

contention of the quantity theory, and such, very explicitly, is

Fisher's contention. The price-level is always effect, and never cause

(with slight modifications of the doctrine for transition periods) in

its relations to the other magnitudes in the equation of exchange.

Now in one sense, it is my own contention that the price-_level_ can

never be a _cause_ of anything. The price-level is an _average_.

Averages may be _indicia_ of causation, but they are not themselves

causes. They are not, in reality, anything _at all_. Causation is a

matter which pertains to the particulars of which the average is made.

But this is not the doctrine of the quantity theory. The quantity theory

does, in certain connections, assign causal influence to the level of

prices, particularly in the theory of foreign exchange, where the

explanation of international gold movements rests on the doctrine that a

price-level in one country, higher than the price-level of another

country, drives money away.[332] It will be seen, in a moment, that

Fisher relies on this principle to prove that the price-level of a

country cannot rise without an increase of money--if it did so rise, it

would drive out the money, and so be forced down again. The point at

issue may be stated in terms of particular prices. The quantity theory

is that, while particular prices may rise from causes affecting them, as

compared with other prices, without a change in money, velocities, etc.,

still there cannot be a rise in the general average, because other

prices will be obliged to go down to compensate. The issue is as to the

possibility of a rise in particular prices, uncompensated by a

corresponding fall in other particular prices, without a _prior_

increase in money, or velocities, or decrease in trade. I take up the

issue in this form. I shall maintain that particular prices can, and do,

rise, without a _prior_ increase in money or bank-deposits, or change in

the volume of trade, or in velocity of money or deposits and also

without compensating fall in other particular prices. Putting it in

terms of Fisher's equation, I shall maintain, as against Fisher, that P

can rise through the direct action of factors _outside_ the equation of

exchange, that as a _consequence of such rise_ the other factors

readjust themselves, and that a new equilibrium is reached which, in the

absence of new disturbances from causes outside the equation, tends to

be as permanent and stable as the old equilibrium was.

In the argument which follows, I shall respect thoroughly the

distinction between "normal" and "transitional" effects. I do not think

that this distinction is properly drawn by Fisher. In my discussion of

the relation between the volume of bank-credit and the volume of trade,

and in other connections, I have shown that Fisher leaves out of his

normal theory most of the concrete factors which do affect both the

concrete magnitudes, and the long run _averages_, of the factors in his

own equation. But for the present, I shall meet him on his own ground,

give his distinctions their fullest weight, and carry my argument

through the "transition" to a point where no further change among the

factors in the equation can be expected as a consequence of the initial

change assumed.